Monday August 10, 12:46 PM
FACTBOX-Five risks to watch for the eurozone
By Paul Taylor
PARIS, Aug 10 (Reuters) - German elections, an Irish EU referendum, Baltic currency worries, a leftwards tilt in the European Commission's policies and a potential new Ukraine gas row could all impact European markets
by the end of this year.
Here are the key risks and what to watch on each issue.
GERMAN ELECTION
The Sept. 27 federal election is the most important vote in Europe this year, with the focus on what form of coalition emerges. The most likely outcome is either a shift to the right in the form of a coalition between the Christian Democrats (CDU) and Christian Social Union (CSU) together with the centre-right Free Democrats (FDP) or a continued grand coalition of the CDU/CSU and the centre-left Social Democrats (SPD).
Latest polls give the CDU/CSU around 36 percent with the Social Democrats trailing behind in the 20-25 percent range -- less than the roughly 30 percent they would need to continue in the grand coalition. The FDP has around 13-14 percent support and the Greens and post-communist Left Party around 10 percent each.
A centre-right coalition would be committed on paper to cutting taxes and might take more decisive action to clean up the banking sector by transferring more of the risk from toxic assets to the taxpayer, an unpopular move but arguably key to a sustainable economic recovery in Germany and the euro zone. In return, the state could insist on taking an equity share in more troubled banks. A centre-right government might also be more willing to let failed companies go to the wall, instead of bailing them out.
A renewed grand coalition would be a recipe for political stalemate and more cautious government. It might extend short-time work schemes to keep down unemployment in the hope of an export-driven recovery.
IRISH EU REFERENDUM
Having rejected the EU's Lisbon Treaty in June 2008, the Irish hold a second referendum on Oct. 2. Opinion polls point to a 'yes' vote this time, with the financial crisis having changed many voters' views of the EU to that of a protector. Dublin has received binding assurances that the treaty does not affect tax sovereignty, Irish family law, military neutrality, workers rights and social policy. However, the polls are notoriously unreliable and a late swing towards a 'no' is entirely possible.
If the Irish vote no, the EU will be plunged into a deeper crisis of confidence. Some countries, including Britain, the Netherlands, Sweden and possibly Poland, would declare efforts to reform EU institutions dead and say the bloc should soldier on under the 2000 Nice Treaty. Others, probably led by France, may talk of forming a vanguard of nations willing to move forward in closer cooperation. There would be much finger-pointing but little action. The EU's voice and influence would be diminished in the world.
If the Irish vote yes, and the Germans adopt a law on parliamentary scrutiny of EU legislation demanded by the German constitutional court, there are two other potential hitches -- the Czech and Polish presidents have so far refused to sign the treaty that their parliaments have approved.
However, a yes from Dublin would likely remove those hurdles. The treaty coming into force, probably on Jan. 1, 2010, would boost the EU's self-confidence. An October summit would choose the first president of the European Council to chair and prepare EU summits, as well as a new High Representative for foreign and security policy who would lead an EU diplomatic service with a large budget.
BALTIC CURRENCY CONTAGION
Despite last month's IMF agreement and the release of 1.2 billion euros in EU balance-of-payments aid, Latvia is not out of the woods. The currency peg remains at risk. If Latvia were forced to devalue -- perhaps by 15 percent, which is the maximum permitted deviation from its central ERM rate -- Lithuania and Estonia would be forced to follow suit. That would cause a wave of defaults on euro loans, mostly owed to the Swedish banks.
Could the rot be stopped there, or would it spread to Bulgaria, which also operates a currency board? And would a Baltic devaluation not lead in turn to a depreciation of the Polish and other central European currencies in what the European Commission fears would be a wave of competitive devaluations?
So far, the great Central and East European meltdown, forecast at the start of this year, has been the dog that didn't bark in the financial crisis. But it may not be over yet.
EUROPEAN COMMISSION TURNS LEFT?
It might seem strange given that conservative parties did so well in the June European Parliament election and dominate most EU governments, but the new Commission taking office in November may be less economically liberal and more interventionist. This is partly because Commission President Jose Manuel Barroso wants the votes of as many socialists and liberals as possible for his re-election by the European Parliament, but it is also due to the political mood in France and Germany, which demands more financial regulation and a new climate-friendly European industrial policy.
Expect to hear a lot about green growth and possibly a new low-carbon restructuring plan for the European car industry. Prepare for battles with Britain over regulation of hedge funds, private equity, derivatives trading and other previously unregulated or lightly regulated pools of capital. In the end, the United States will set the benchmark for what the EU does. Britain will not be able to convince Brussels to do less on financial regulation than Washington does.
RUSSIA-UKRAINE GAS ROW?
Despite efforts by the European Union to prevent recurrent turn-of-the-year crises over Russian gas supplies through Ukraine to western Europe, there is a strong chance of another gas crisis before Ukraine's presidential election next January. A partial or total gas cut-off would do relatively little immediate harm since stocks are high in western Europe, demand is low due to the recession and importers have been buying Liquefied Natural Gas which has been temporarily cheaper. However, there are still parts of central and south-eastern Europe, notably in Slovakia, Bulgaria and Serbia, that would be immediately hit by a gas cut-off.
The EC has brokered an agreement among the EU, Ukraine and international lenders whereby Kiev will borrow money to pay for Russian gas stored on its territory in return for reform of the Ukrainian gas sector, greater transparency and an end to domestic Ukrainian price subsidies. However, it is not clear whether the Ukraine will stick to this timetable in the run-up to its presidential election on Jan. 17 and Moscow may again play with the gas taps to influence the poll in favour of a pro-Kremlin (Frankfurt: 513350 - news) candidate.
-- Paul Taylor is Reuters European policy columnist --
(editing by Peter Apps) Keywords: EUROPE EUROZONE/RISKS
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